No “One-Stop Shopping” to Resolve Tax Disputes: SCC Decisions in Dow Chemical and Iris Technologies

No “One-Stop Shopping” to Resolve Tax Disputes: SCC Decisions in Dow Chemical and Iris Technologies

Introduction

Contrary to what taxpayers often assume, the Tax Court of Canada (“TCC”) does not have jurisdiction over a wide range of disputes with Canada Revenue Agency (“CRA”). Matters such as the refusal to cancel interest or the improper withholding of refunds must generally be litigated in Federal Court. Matters involving provincial tax credits must generally be litigated in Superior Court. Claims against the CRA for damages caused by incorrect guidance and/or abusive conduct—to the extent that such claims can be litigated at all—must generally proceed in the Federal Court or Superior Court. The jurisdictional lines between the courts represent a common source of confusion, and feature both overlaps and gaps.[1] Accordingly, there have been numerous calls for an expansion of the TCC’s jurisdiction to enable it to resolve a greater range of the disputes that taxpayers seek to bring before it.

Consequently, when the Supreme Court of Canada (“SCC”) agreed to hear Dow Chemical Canada ULC v. Canada, 2024 SCC 23 (“Dow Chemical”) and Iris Technologies Inc. v. Canada (Attorney General), 2024 SCC 24 (“Iris Technologies”), there was much hope and anticipation that, at a minimum, the SCC would endorse a more expansive approach to the TCC’s jurisdiction. These hopes, however, were dashed with the narrow 4-3 decision in Dow Chemical and unanimous decision in Iris Technologies, which entrenched the existing allocation of jurisdiction and signaled that any reform would have to come from Parliament.

The Decisions

Dow Chemical concerned a transfer pricing dispute involving the taxpayer’s transactions with a related Swiss company involving both upward and downward adjustments. The TCC unquestionably has jurisdiction over disputes over upward transfer pricing adjustments. At issue, however, was whether a refusal by the CRA to implement a downward adjustment could also be appealed to the TCC, or whether it could only be challenged in the Federal Court. The issue arose due to subsection 247(10) of the Income Tax Act (the “ITA”), which states that a downward transfer pricing adjustment cannot be made unless “in the opinion of the Minister [of National Revenue (i.e., the CRA)[2]], the circumstances are such that it would be appropriate that the adjustment be made”. In other words, downward adjustments are “discretionary” and conventional wisdom has long held that discretionary CRA decisions can only be challenged on judicial review in Federal Court. In addition to the potential inconvenience of having to address two courts, judicial review proceedings in the Federal Court can be less advantageous to the taxpayer insofar as they generally do not allow new evidence and the Court will defer to the CRA’s decisions, intervening only if the decision is “unreasonable”. In TCC appeals, in contrast, the Court can generally hear new evidence and will independently make its own decision, without deference.

A sharply divided SCC endorsed that conventional wisdom, the majority holding that deciding otherwise would “leave the dividing line between the Federal Court and the Tax Court’s respective jurisdictions in disarray”,[3] and that “[i]t is plainly in the legislative branch where far-reaching considerations related to the jurisdictional divide between the Federal Court and the Tax Court should be studied and considered.”[4] Accordingly, disputed upward adjustments must be litigated in the TCC and downward adjustments in Federal Court, even if those adjustments are reflected in a single reassessment.

Iris Technologies involved an Excise Tax Act (“ETA”) dispute where the CRA withheld substantial GST refunds pending an audit. The taxpayer applied in Federal Court for a writ of mandamus ordering the issuance of its refunds. Prior to the hearing of the application, without any notice to the taxpayer and prior to the completion of the audit, the CRA issued an assessment disallowing $98 million of input tax credits and imposing over $24 million in penalties. It bears note that in GST matters, all assessed amounts are immediately collectible even if disputed.

The TCC unquestionably had exclusive jurisdiction over the taxpayer’s entitlement to the input tax credits and liability for penalties. Nevertheless, the taxpayer initiated judicial review proceeding in the Federal Court seeking declarations that the CRA issued the assessments without evidentiary foundation and in a procedurally unfair manner (in particular, without providing prior notice and allowing the taxpayer to make representations), all for the improper purpose of circumventing the mandamus proceedings. Given that a well-established line of cases has held that the TCC does not have jurisdiction to review the CRA’s “conduct” leading to an assessment—the leading case being Main Rehabilitation[5] from the Federal Court of Appeal—the taxpayer argued that the only place to obtain the declaratory relief sought was in the Federal Court. The CRA moved to strike the application as a collateral attack on the assessments.

The SCC unanimously agreed with the CRA, issuing a majority opinion and a minority concurrence. Both camps agreed that: (a) the full hearing offered by the TCC offered an adequate remedy for an assessment issued without evidentiary foundation and without affording a taxpayer an opportunity to make submissions, and (b) that the declarations sought, even if obtained, would have no practical effect. The two camps differed slightly with respect to how/whether a taxpayer can challenge an assessment on the basis that it was issued for an “improper purpose”, but both agreed that the taxpayer in Iris Technologies did not meet the requirements to do so.

Observations

The current allocation of jurisdiction among the various courts is not the result of a methodical consideration of which disputes belong in which forum, but rather seventy-five years of incremental decisions—including some having nothing to do with tax administration. While there is an increasingly strong consensus that the current system is broken, it can arguably claim implicit Parliamentary endorsement given that tax legislation is constantly amended. In this light, Dow Chemical’s holding that any reform must come from Parliament, although disappointing, does not come as a complete surprise. Taxpayers can only hope that Parliament will take up the Court’s invitation.

Although the result in Iris Technologies was largely expected, there was some hope that the Court would walk back Main Rehabilitation and suggest that the TCC had the jurisdiction to vacate an assessment on the grounds that it had been issued abusively and in a procedurally unfair manner. The SCC, however, largely dashed these hopes with repeated statements to the effect that the assessment of tax is a matter over which the CRA has “no discretion”. While such statements from the courts are hardly new,[6] the reality is far more nuanced. Canada’s tax system is based on self-assessment; the CRA conducts audits to verify compliance of a relatively small proportion of taxpayers. The CRA has considerable discretion in deciding who to audit, how intensively to conduct an audit, when and whether to terminate an audit with or without an assessment, and—perhaps most importantly—to enter into settlement agreements over a taxpayer’s liabilities. As a practical matter, how the CRA exercises these extensive discretionary powers can have enormous impact on how much tax a taxpayer has to pay.

Perhaps more fundamentally, while it may be legally correct to say that—with a few exceptions such as downward transfer pricing adjustments—the amount of person’s tax liability is not at the CRA’s “discretion”, many factors that affect that liability rely on subjectivity and judgement, such as the fair market value of a given asset, or whether a given contract represents a single or composite supply. The CRA publishes extensive guidance that aims to ensure that such determinations are made consistently and in a principled manner, in accordance with the policy objectives of the ITA and ETA. The CRA publishes similarly extensive guidance with respect to how it exercises its discretionary powers. Ultimately, if one assumes that the CRA can and should exercise its “discretionary” powers in a likewise consistent and principled manner in accordance with good fiscal policy, the conceptual difference between a matter of “discretion” and one of “subjectivity and judgment” is far from self-evident.

Indeed, perhaps the main conceptual difference between a matter of “subjectivity and judgement” and one of “discretion” is simply the procedural vehicle through which disputes in relation to that the matter are resolved, with the former being decided afresh by the TCC, and the latter being reviewed by the Federal Court on the prior record with deference. If so, however, one is left to wonder why taxpayers should be denied the opportunity to have the independent, specialist judges of the TCC adjudicate “discretionary” matters in the same manner as they adjudicate matters of “subjectivity and judgement”. It bears reflection that back in the early 1940s, many income tax deductions (such as depreciation) were at the Minister’s discretion, and Parliament undertook a major reform in 1948 to remove almost all of these discretionary provisions on the grounds that they were not appropriate from a standpoint of fiscal administration. One may wonder whether the time has come for a similar reform today.

[1] For a more complete discussion, see Michael H. Lubetsky, “The Fractured Jurisdiction of the Courts in Income Tax Disputes,” in Tax Disputes in Canada, Canadian Tax Foundation (2022). This article was cited repeatedly by both the majority and dissenting judges in Dow Chemical.
[2] The CRA exercises, by delegation, the powers conferred on the Minister of National Revenue under the ITA, ETA and other fiscal legislation.
[3] Dow Chemical ¶11. One might cynically quip that the word “more” should precede “disarray”.
[4] Dow Chemical ¶14-15, 115.
[5] Main Rehabilitation Co. v. Canada, 2004 FCA 403 (“Main Rehabilitation”). For a more fulsome review of the case law, see Guy Du Pont & Michael H. Lubetsky, “The Power to Audit is the Power to Destroy Judicial Supervision of the Exercise of Audit Powers” (2013) 61:3 Canadian Tax Journal 81, 61:3 (2013). This article was cited by the dissenting judges in Dow Chemical.
[6] See Canada (Attorney General) v Collins Family Trust, 2022 SCC 26 ¶25.

by Michael H. Lubetsky

A Cautionary Note

The foregoing provides only an overview and does not constitute legal advice. Readers are cautioned against making any decisions based on this material alone. Rather, specific legal advice should be obtained.

© McMillan LLP 2024